Stocks hold up against oil price

Record energy prices fail to dent stock market's gains

By

WanfengZhou

NEW YORK (MarketWatch) -- The gradual manner in which oil prices have climbed over the past three years, instead of jumping suddenly, has teamed with some solid economic data to help the U.S. stock market weather record-high energy prices, equity strategists say.

The market's resilience has surprised many investors with the results: The Nasdaq Composite
DJC, +0.48%
is currently trading at its highest level for the year, while the Dow Jones Industrial Average
DJIA, +0.72%
is a mere 4% shy of a multiyear high. And that's just one week after crude futures hit an all-time intraday record of $61.90.

"The key difference in the oil-price triplings of recent years versus those that occurred in the 1970s has been the amount of time that it took for these increases to occur," said Tobias Levkovich, chief U.S. equity strategist at Citigroup Smith Barney.

The gradual price increase has given the economy and consumers more time to adjust to price changes, he said.

"Conversely, when the oil price tripling occurs abruptly [as was the case in the '70s], consumers have taken a hit."

There were three occasions when oil prices tripled in a very short timeframe: from 1973-74, during the Arab oil embargo; during the 1979-80 revolution in Iran; and immediately after the 1990-91 invasion of Kuwait by Iraq. In each case, consumers were forced to economize quickly to counter the rise.

In contrast, when the price of West Texas intermediate futures rose from about $11 in 1998 to more than $30 by early 2000, the equity markets performed well, said Levkovich.

"When oil prices triple, there is no certainty of economic malaise," he said. "Equity markets can do quite well if economic conditions exist that allow absorption of the energy price increases."

A gradual rise

Crude-oil prices have again risen at a gradual pace over the past three years, driven by growing demand from China and India and concerns about supply and capacity constraints.

Since Oct. 9, 2002, when the major stock-market indexes closed at their bear-market lows, crude prices have more than doubled. The August 2005 contract closed at $60.62 on Tuesday, up 107% from the November 2002 contract close of $29.35.

Over the same time, the Dow Jones Industrial Average has gained 44%, and the Nasdaq Composite has climbed 92%. And leading the way for stocks, the CBOE Oil Index has advanced 107%.

Since the end of April, when the stock indexes bounced off their 2005 lows, November crude has gained 16%, while the Dow has added 3.1%, the Nasdaq has moved up 11%, and the oil-sector tracker has rallied 14%.

Thorsten Fischer, a senior economist at Economy.com, said a string of solid statistical reports has reinforced the belief that the U.S. economy is on solid footing and has bolstered the market's ability to withstand higher energy prices.

Gross domestic product, for example, increased at a 3.8% annual rate in the first quarter. The labor market -- which directly impacts real consumer spending -- appears to be picking up. Unemployment fell to a four-year low of 5% in June.

Although the economy added a weaker-than-expected 146,000 jobs that month, the overall employment level is still well above that seen at the economy's peak in 2000, and the growth outlook remains upbeat, according to Levkovich.

"We should be encouraged by the fact that the U.S. added about 2.2 million jobs last year and is on pace to add roughly the same amount this year," he said.

More spending power

U.S. personal income jumped $527 billion in 2004, while energy costs increased by roughly $50 billion during the same period, according to Citigroup economist Steven Wieting.

At the same time, retail sales continue to show resiliency, and retailers' stocks have been outperforming the broader market alongside oil-price gains.

Economy.com's Fischer said the fact that today's soaring oil prices are largely driven by demand, and not by supply as in prior shock periods, is a positive sign.

"Unlike during earlier periods, this time high crude-oil prices in general are demand-driven," said Fischer. "It reflects that the economy is strong ... and business and industry demand more energy, and that drives up the price."

Kenneth Tower, chief market strategist at CyberTrader, said the limited impact oil has had on the market is also due to the fact that, on an inflation-adjusted basis, oil prices are just slightly higher today.

Nominal oil prices are about 48% higher this year than they were in 1990, but, after inflation adjustment, the increase is only 1%, according to an estimate by the New York Times.

"Relative to other prices, crude oil was quite low just a few years ago," said Tower. "This increase in energy costs has essentially been a catch-up, rather than what we've seen in nominal prices, which moved to record highs."

Tower said oil prices won't discrupt the market until they're high enough to change people's behavior, making them cut back on driving and shopping.

"We suspect that energy prices will not become an overwhelming headwind in coming months as long as aforementioned job growth is sustained," Levkovich said.

Brian Hicks, co-manager of the Global Investors Global Resources Fund, said he wouldn't be surprised to see a spike higher than $62 when the peak demand period comes in the fourth quarter.

A prolonged period of oil prices in the $60 a barrel region may be tougher for investors to withstand.

"We averaged over $50 a barrel in the first quarter," Hicks said. A $60-a-barrel price "could be a different story."

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.